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Executive Summary

The National Commission of Audit was established to examine the scope and efficiency of the Commonwealth Government, to review the state of its finances and to advise on steps to ensure Australia’s long-term fiscal strategy is responsible and sustainable.

The Commission has found Australia confronts a substantial budgetary challenge – the fiscal situation is far weaker than it should be and the long-term outlook is ominous due to an unsustainable increase in expenditure commitments.

There is a big task ahead to restore the nation’s finances. The Commission has therefore focused on the biggest and fastest growing areas of spending to identify savings. A detailed portfolio‑by‑portfolio review should yield significant additional savings.

As a nation we have a responsibility to complete the task of budget repair. If we succeed we will remove an unfair future burden on young people. We will also help to shock-proof the economy against future crises. More efficient government will create greater overall capacity and will allow us to generate more wealth.

The interests of the nation are best achieved by promoting responsible government.

Fiscal responsibility and reducing government expenditure does not have to harm the economy if it is done incrementally, fairly and as part of a well explained programme of reform.

‘Business as usual’ is not an option for Australia. The Commission therefore proposes 64 recommendations to place Commonwealth spending on a more sustainable long-term footing.

We have looked at a wide range of options across major programmes. The recommendations in this report are the ones which the Commission considers meet the Principles of Good Government.

Of course these are recommendations only and it is the decision of the elected Government which of them, if any, they choose to progress.

The Commission has not undertaken detailed costings of these recommendations but depending on when they are implemented we expect that significant savings will be built up over time.

By 2023-24 these savings could reach $60 to $70 billion per year and could be higher once additional savings from lower interest costs arising from reduced debt levels are taken into account.

In many areas, reducing government expenditure as well as red tape and compliance costs will open opportunities for the private sector. Also the private sector will often be better placed to deliver services more efficiently.

We also recognise that any consideration of the size, scope and efficiency of government must extend to the operation of our Federation. It is wasteful and costly for different levels of government to intervene in the same areas of spending.

Reform of the Commonwealth’s fiscal strategy is a long-term project for our whole society that goes far beyond the normal budget period. It will require an integrated approach with hard-headed decisions on spending priorities, a preparedness to embark on meaningful tax reform, an ambitious approach to recasting Commonwealth-State relations and, above all, a concerted reform agenda to support productivity and growth.

The extent of what is required over the next 10 years and beyond needs to be appreciated by everybody. Governments, commentators and the media generally have a role to play in ensuring that they understand and shape the debate in an informative way for Australians.

Government should not make promises that cannot be afforded over the long-term. Households understand they must live within their means. Governments must do so too.

In undertaking this Audit, the Commission has been guided by the importance of fairness, recognising that fairness has a strong relationship to our sense of confidence and our ability to work together effectively.

Inevitably vested interests will seek exemption from the shared sacrifice and common purpose. We must reassess our expectations of government in the light of the overall good. National interest and not special interest must prevail.

It is only in this way that we can maintain a fair and cohesive society and afford the level of support to the deeply disadvantaged which is the hallmark of a civilised society and a defining characteristic of Australia.

Principles of Good Government

In examining the scope, efficiency and sustainability of the Commonwealth Government and its programmes, the Commission has developed a set of common sense principles to guide its deliberations.

These core principles have shaped our approach and helped ensure our fiscal goals can be achieved in a way the community understands and supports.

Live within your means. All government spending should be assessed on the basis of its long-term cost and effectiveness and the sustainability of the nation’s long-term finances.

Harness the benefits of the Federation but demand a responsible Federation. The Commonwealth’s activities should be guided by the Constitution. The States and Territories should be free to compete amongst themselves, respecting the regional differences of a big continent. However, there will be occasions where the national interest calls for a cooperative and national approach.

Protect the truly disadvantaged. Government should protect the truly disadvantaged and target public assistance to those most in need.

Respect personal responsibility and choice. Government should not and cannot eliminate or insure every risk to the community. Personal responsibility and choice are fundamental to our democratic system.

Assure value for taxpayers’ money and ministerial responsibility. Governments spend taxpayers’ money not the government’s money. They must assure value across all expenditure and constantly strive to improve productivity and eliminate waste. All programmes should be regularly assessed for effectiveness against their stated goals and outcomes. Ministerial responsibility is imperative and departments should be the primary source of policy advice.

Be transparent and honest. Transparency and honesty are fundamental to accountability. Government policy goals and programme outcomes must be transparent. Transparency in government will better illuminate the choices we face and the decisions needed for the overall good of the nation. Spending on lower priorities, however popular at the time, needs to be resisted.

Reduce complexity. Government should reduce complexity which impacts on its own operations, the operations of the States and Territories and the activities of the community and business. Reporting requirements should be kept to a minimum.

Avoid regulation as a first response to a problem. Adding new regulations to deal with problems should be the last resort and introduced only when existing laws prove inadequate and the risks of no regulation outweigh the costs to the community.

Act in the public interest and recognise the benefits of markets. In competitive markets, customers, not producers, take precedence. Competition and contestability drive lower costs, improve quality and give people what they want. Government should act in the public interest and only intervene in markets where market solutions fail to produce the best outcome for the nation as a whole.

Do not deliver services if others are better placed to do it. The delivery of public services should, wherever practicable, be handed to those organisations and levels of government closest to those receiving the service and should not be duplicated.

The state of the Commonwealth’s finances and fiscal outlook

The Government’s fiscal strategy stipulates a budget surplus equivalent to 1 per cent of Gross Domestic Product prior to 2023-24 and this is key to our Terms of Reference. The Commission regards this as a prudent and sensible goal. With no further global or domestic shocks, it will allow us to pay down our debt to future-proof the economy against the next crisis.

For the year ended 30 June 2013, the Commonwealth Government recorded an underlying cash deficit of $18.8 billion, or 1.2 per cent of GDP. In the current 2013-14 financial year the underlying cash balance is projected to record a deficit of $47.0 billion or 3.0 per cent of GDP. This is the sixth consecutive budget deficit. We have spent beyond our means for too long.

The 2013-14 Commonwealth finances reflect:

projected Commonwealth payments of $409 billion, amounting to 25.9 per cent of GDP; and

projected Commonwealth taxation receipts of $343 billion or 21.8 per cent of GDP. After taking account of some $21 billion of expected non-tax receipts, total Commonwealth revenue is projected to be 23.1 per cent of GDP.

Commonwealth Government spending as a share of GDP remains close to the recent peak of 26.0 per cent recorded in 2009-10 and is well above the average of the past 20 years of 24.6 per cent of GDP.

The size and scope of government has increased significantly over time. Over the last 40 years government spending has nearly tripled in real terms, from around $6,000 per person per year to over $15,000 per person today. (See Chart 1.) The growth in real payments per person reflects the greater role that government plays in the lives of Australians and the economy.

As well as government policy and higher expectations from the community, higher public spending reflects the ageing of Australia’s population and the fact that there are, proportionally, far more older people now (who tend to receive more government services). While we can’t do anything about our country’s age profile, we can curtail our spending.

Chart 1: Real spending per person

Commonwealth tax receipts as a share of GDP have been subdued in recent years. As shown in Chart 2, at a current level of 21.8 per cent of GDP tax collections are below the 20-year average of 22.4 per cent of GDP and well below the 23.6 per cent of GDP recorded in 2007‑08 just prior to the global financial crisis.

Chart 2: Commonwealth taxes as a share of GDP

The Commission’s approach

The main focus of the Commission was on the largest and fastest growing areas of Commonwealth spending, industry assistance and other programmes and the rationalisation of Commonwealth bodies and agencies. A more detailed review of every portfolio will no doubt find further ways of improving government.

Of the $409 billion of total Commonwealth spending in 2013-14 only 12 per cent (or just under $50 billion) is categorised as agency and departmental spending. The remaining 88 per cent of spending (or some $360 billion) is classified as ‘administered’ payments. The vast majority of these payments are governed by legislation and established eligibility rules which mean there is little discretion as to whether they are made. They largely include demand-driven payments in social security and health.

It is important to reduce waste and improve efficiency in government. However, the savings required to restore the nation’s finances will need to go well beyond simply reducing costs in the public service.

Structural savings in the largest and fastest growing programmes must be pursued over coming years if the Government’s fiscal target, as specified in the Terms of Reference, is to be realised.

Looking ahead 10 years, any outlook for the Commonwealth’s finances will necessarily be inexact. Nonetheless, on the spending side it is possible to obtain a reasonable approximation of likely trends on the basis of what we know about expected population growth, demographic changes, the formulas used to increase payments each year and likely take-up rates for certain programmes.

As shown in Chart 3, projected Commonwealth spending is likely to rise from $409 billion today to some $690 billion in nominal terms over the next 10 years.

Over this period combined growth in spending on social security, welfare, health and education is projected to contribute the most to growth in total expenses.

Most of the future growth in spending is concentrated in the 15 largest and fastest growing Commonwealth programmes, which account for around 70 per cent of total growth in spending over this period.

Chart 3: Projected Commonwealth spending

High level overview of major programmes

Of these 15 programmes, the Age Pension is by far the largest. Currently close to $40 billion, the Age Pension is forecast to rise by 6.2 per cent per year from 2013-14 to 2023-24, when spending is projected to be over $72 billion. Spending will continue to grow from there.

Of this $32 billion increase, around 40 per cent is driven by current indexation arrangements with most of the remainder due to increasing numbers of recipients.

Three large health programmes — Medicare, hospitals and pharmaceutical benefits — now account for over $40 billion in Commonwealth spending.

The Medicare Benefits Schedule currently costs around $19 billion and is expected to grow by 7.1 per cent per year until 2023-24 and continue growing. The increase in expenditure largely reflects population growth and increasing use and cost of medical services.

Spending on hospitals (currently $14 billion) is expected to rise to around $38 billion by 2023-24 and continue growing. The Commonwealth contributes to the funding of public hospitals in the States through Australian Health Care Agreements. With annual growth of 10.4 per cent between 2013-14 and 2023-24, spending on hospitals is one of the fastest growing areas of government spending.

Spending on the Pharmaceutical Benefits Scheme is projected to grow by 5.4 per cent per year from 2013-14 to 2023-24 and continue growing. At present, nearly 80 per cent of the Scheme’s expenditure is attributable to concessional recipients.

The National Disability Insurance Scheme commenced in 2013 and is expected to grow rapidly. From a starting point of less than $0.5 billion for the next three years, average annual growth is projected to be over 45 per cent from 2013-14 to 2023‑24. This means that by 2023-24, NDIS spending by the Commonwealth alone will be around $11 billion.

Payments to Carers are projected to increase by 9.6 per cent per year between 2013-14 and 2023-24 and continue growing. Rapidly rising beneficiary numbers are one of the main drivers, with annual increases in excess of 10 per cent for recipients of some payments.

Aged care is growing strongly and is forecast to double from its current level of around $13 billion to $26 billion in 2023-24 and continuing to grow. The increasing number of older Australians accessing aged care services is the main driver of this growth in costs. Residential care is the largest component of aged care spending.

In 2013-14, nearly $16 billion is expected to be spent on the 820,000 recipients of the Disability Support Pension. Over the next 10 years spending on this Pension is projected to increase by 4.7 per cent per year. Population ageing drives part of the growth but a significant portion is due to indexation. The Disability Support Pension is indexed in the same manner as the Age Pension.

Growth in child care fee assistance and Paid Parental Leave is expected to be around 11.5 per cent per year between 2013-14 and 2023-24. This reflects increased usage of formal care, for which the Commonwealth provides two major subsidies and the proposed changes to the Paid Parental Leave scheme.

Family Tax Benefit is growing less strongly than other areas, but is still a substantial programme. At around $19 billion, it makes up close to 5 per cent of all Commonwealth government spending and is projected to be over $22 billion in 2023-24.

Commonwealth spending on job seekers is currently over $10 billion. Growth in expenditure in this area is not projected to be large as it is dependent on the unemployment rate, which, consistent with the medium-term projection methodology is assumed to remain at around 6 per cent.

Commonwealth spending on education is around $20 billion, with around $13 billion on schools and the remaining $7 billion on higher education.

Schools funding is expected to grow by 9.2 per cent per year to 2023-24. This growth largely reflects indexation arrangements and per student funding goals under the Better Schools Plan.

Growth in higher education funding (5.8 per cent per year between 2013-14 and 2023-24) partly reflects the effect of uncapping the number of bachelor degree places in Australian universities in a demand-driven system with the Commonwealth effectively underwriting places through subsidised student loan arrangements.

In 2013-14 around $25 billion will be spent on Defence. This figure is forecast to increase above $40 billion by 2023-24 and will rise to $52 billion by then if the Government increases Defence spending to its target of 2 per cent of GDP. At the same time, Defence spending is facing ongoing cost pressures, reflecting the increasing costs and complexity of military equipment (often associated with increased capability), and personnel.

Australia’s foreign aid programme is forecast to grow on average by 9.6 per cent per year between 2013-14 and 2023-24. The vast majority of this growth is attributable to the previous government’s commitment to Australia’s foreign aid programme reaching 0.5 per cent of Gross National Income.

Revenue outlook

The Commonwealth is highly reliant on personal and corporate income taxes, which are closely linked to the economy’s performance and the terms of trade.

The combination of the Commonwealth’s high reliance on volatile taxes, combined with volatility in our terms of trade, imposes significant risks to the medium-term revenue outlook and increases uncertainty around revenue forecasts.

The long-term sustainability and stability of the Commonwealth’s revenue is a serious matter.

The Commission has not, however, dealt extensively with taxation issues. This recognises that other processes will soon commence. The Government has committed to consult the community to produce a comprehensive Taxation White Paper with all aspects of the tax system ‘on the table’. This White Paper, alongside the Government’s proposed Federation White Paper, provides a significant opportunity to improve government and strengthen the economy.

The Commission has assumed tax receipts will rise in line with a strengthening economy, with the tax to GDP ratio recovering to normal levels over time. Once tax receipts reach 24 per cent of GDP — which is around the average level of tax receipts over the period from 2000 to the lead up to the global financial crisis — they are assumed to remain at that level.

This reflects a critical assumption that additional tax collections arising from bracket creep (as wages growth pushes taxpayers towards higher tax brackets) are partially returned by the government in the form of periodic income tax cuts. This is the established practice of Commonwealth governments over many decades.

If adjustments are not made for bracket creep the Commission estimates that a person earning the average wage and currently facing a marginal tax rate of 32.5 per cent will be taxed at a 37 per cent marginal tax rate by 2023-24. The marginal tax rate for a person on the minimum wage would rise from 19 per cent now to 32.5 per cent well before 2023-24. In the Commission’s view, having proportionally more people subject to higher tax rates will have negative implications for Australia’s economic growth.

The Commission’s fiscal scenarios

The Commission has prepared two fiscal scenarios: a ‘Business as Usual’ scenario and a ‘Reform’ scenario.

These scenarios involve assessments and judgements about future growth in receipts and payments at the Commonwealth level and are based on assumptions around economic growth and inflation that are reasonable and sensible. Over the medium term, nominal GDP is projected to grow by just over 5 per cent per year, with inflation growing by around 2.5 per cent per year.

Under ‘Business as Usual’ it is assumed that Commonwealth spending out to 2023-24 follows a similar path to the one outlined in the Mid-Year Economic and Fiscal Outlook. Spending as a share of GDP is projected to reach 26.5 per cent of GDP at that time.

Tax receipts in the ‘Business as Usual’ scenario are assumed to remain at or below 24 per cent of GDP. When non-taxation receipts, such as dividends and other income, are included total Commonwealth receipts reach 25 per cent of GDP and remain at around that level.

In this ‘Business as Usual’ scenario the Commonwealth’s Budget remains in deficit out to 2023-24 and beyond.

If this occurred, Australia would record an unprecedented run of 16 consecutive years of deficits (and more in prospect), with net debt rising to around 17 per cent of GDP or some $440 billion. This would place a significant burden on future generations to bring the Budget back under control and of course reduces any buffer to meet future shocks.

If a shock hits and we don’t have a buffer in place then it is more likely that governments will have to cut back dramatically and more painfully.

This is important if governments are to be conscious of not making cuts that impact on the most vulnerable.

In the Commission’s ‘Reform’ scenario, a more moderate pace of spending growth occurs over the medium term. In particular, it assumes additional expenditure restraint starts in 2014‑15 and is maintained through to 2023-24.

Under this scenario Commonwealth payments would decline from their current level of around 26 per cent of GDP to around 24 per cent of GDP by 2023-24.

Tax receipts in the ‘Reform’ scenario are assumed to be the same as the other scenario - remaining at or below 24 per cent of GDP. When coupled with non-taxation receipts total Commonwealth receipts are assumed to reach 25 per cent of GDP and remain at around that level.

Under the ‘Reform’ scenario the Budget returns to surplus in 2019-20 with the surplus growing to 1 per cent of GDP by 2023-24.

Commonwealth net debt peaks at 15.1 per cent in 2016-17 under this scenario and then declines to just over 5 per cent of GDP.

These scenarios are illustrated in Chart 4.

Chart 4: The Commission’s fiscal scenarios

‘Business as Usual’ scenario

'Reform' scenario

Restoring the nation’s finances

The Commission has identified those areas which must be addressed to place the Nation’s finances on a sustainable footing.

The Commonwealth requires a credible medium-term fiscal strategy, which provides certainty. It requires acceptance of fiscal rules that set boundaries around government while continuing to allow some flexibility in implementing policy priorities. Adherence to these rules will help to shock-proof the economy.

Our federal system is not working as it should and reform of its operation is essential to the future of the nation. We must clearly delineate respective roles and responsibilities and reform the Commonwealth’s financial relations with the States and Territories (hereafter ‘the States’). The Commonwealth must withdraw from certain areas and in return, the States will need access to and control of a bigger and more sustainable revenue base. Reforming the Federation is essential to the improved accountabilities needed for responsible government in Australia.

Major reforms to the largest and fastest growing areas of Commonwealth spending offer the clearest opportunities for managing and restraining growth in overall government expenditure. Accordingly, the Commission has identified reforms to the 15 largest and fastest growing spending programmes to ensure they can be placed on a more sustainable footing. Their combined impact over time is the driver of the Commonwealth’s fiscal challenge.

In addition the Government will need to rationalise and streamline many of the things it currently does and in some areas cease activity. This includes rationalising the number of bodies and agencies, ending many grant and other ineffective programmes, limiting industry assistance, streamlining functions and where possible devolving responsibility to the States.

The Government should apply more market-based and technological solutions to improve the quality and efficiency of its services. It should consider further opportunities for privatisation and outsourcing. It needs to make greater use of data and data analysis techniques and information technology. It should also make greater use of private sector expertise in the design and delivery of services including e-Government services.

Fiscal strategy and new fiscal rules

For the past 25 years there has been bipartisan support in Australia for fiscal policy guided by established rules and set with an eye to the medium term. This strategy was based on generating budget surpluses on average over the course of the economic cycle and reducing government debt.

However, in recent years, the strategy was discarded.

More than four years into the economic recovery from the global financial crisis the Budget should not be in deficit to the tune of 3 per cent of GDP as is currently in prospect for this year.

The Commission considers the central elements of the fiscal strategy that has been in place for nearly two decades should be restored to promote stability and consistency in Australia’s overall fiscal framework.

However, execution of the fiscal strategy requires a more prescriptive approach, with a new set of operational rules to better frame fiscal policy choices and enable a more transparent assessment of government fiscal performance.

The Commission considers the surplus target of 1 per cent of GDP, included in its Terms of Reference, is appropriate and achievable. It should be part of the new fiscal rules. A target surplus of this size has been achieved historically and will ensure that meaningful inroads are made into reducing debt.

The Commission considers fiscal policy should be set with a view to reducing net debt over time.

In effect, this strategy of keeping net debt relatively low (or slightly negative) is designed to provide a ‘corridor of stability’ or safe harbour within which governments can operate. It will help to shock-proof the economy.

We also need discipline on the ratio of tax to GDP limiting the burden of taxation on the economy.

A pragmatic approach is to adopt a tax to GDP cap of 24 per cent, which is around the average level of tax receipts recorded over the period from 2000 to the onset of the global financial crisis. This would allow for some growth to occur in the tax to GDP share from the current tax level of 21.8 per cent of GDP as the economy strengthens.

Overall, the Commission considers the Government should adopt a high-level fiscal strategy which seeks to achieve underlying cash surpluses, on average, over the cycle, improve the government balance sheet over time and limit the size of government.

Accordingly the Commission recommends the following fiscal rules:

achieving a surplus of 1 per cent of GDP by 2023-24;

substantially reducing net debt over the next decade; and

ensuring taxation receipts remain below 24 per cent of GDP.

As shown in Chart 5 below, these rules would not be met under the ‘Business as Usual’ scenario. Australia’s net debt would rise above 15 per cent of GDP and remain elevated through to 2023-24 and beyond.

In contrast, under the ‘Reform’ scenario (which produces a surplus of 1 per cent of GDP by 2023-24) net debt would decline to around 5 per cent of GDP. Maintenance of small surpluses beyond this time would see net debt reduce further.

Chart 5: Commonwealth Government net debt

The Commission acknowledges fiscal rules should not be completely inflexible. In the event of a rare economic shock (for example of the order of the global financial crisis), the automatic stabilisers in the Budget should be allowed to operate, with discretionary fiscal policy used to support macroeconomic demand as appropriate.

In these circumstances, the core elements of the proposed rules would remain, possibly with an ‘escape clause’ which allows temporary adjustments to the timing and/or size of the surplus target, so as not to damage short-run growth.

Conversely, a temporary boost to tax receipts — arising from, for example, an unexpected and marked rise in the terms of trade — that pushed taxes over 24 per cent of GDP could be accepted as long as it was temporary and the proceeds were not spent but used to reduce the deficit or pay down debt.

The prudent design of escape clauses can provide flexibility to rules in dealing with rare events and are advocated by the International Monetary Fund as an acceptable part of a suite of fiscal rules. They do, however, need to be carefully specified.

Currently, there is no public mechanism for reporting a government’s progress against, and adherence to, the fiscal strategy. Having such a mechanism would improve accountability and transparency of a government’s fiscal situation and direction.

Within Australia, the Parliamentary Budget Office was established to inform the Parliament by providing independent and non-partisan analysis of the Budget cycle, fiscal policy and the financial implications of proposals.

The Commission recommends the Charter of Budget Honesty Act 1998 be amended to require the Parliamentary Budget Office to report progress against the government’s medium-term fiscal strategy following the release of the Final Budget Outcome each year.

The Commission also considers there is scope for improving the overall transparency of budget reporting.

There is currently no requirement for budget updates to include aggregate budget estimates any further than three years beyond the Budget year. However, at an aggregate level medium-term projections have been published in Budget updates for the past few years.

The Charter of Budget Honesty should be changed to make it mandatory for each fiscal update to include projections for the 10 years beyond the Budget year, including for spending and revenue aggregates and the underlying cash balance, based on current policy settings. Such an approach in the past may have avoided the situation we now find ourselves in.

The Commission considers the preparation and publication of a regular Intergenerational Report has been a positive development for Australia, particularly in raising awareness of the budgetary challenges of the ageing population.

The Intergenerational Report should be retained as a key document to increase budget transparency. There should be a requirement that it be produced within a specified period after the release of the National Census. In addition, the Commission considers future Intergenerational Reports should also cover the long-term sustainability of State and Territory budgets.

The Commonwealth’s balance sheet

A government’s balance sheet is an important measure of its financial position. Not only is it an indicator of short term fiscal sustainability and the government’s ability to respond to economic shocks, it also reflects the debt and other liabilities that must be repaid by future generations.

The Commission considers there is merit in raising community awareness of the balance sheet’s importance. A greater focus on the balance sheet would broaden the debate on fiscal policy and encourage better asset management.

Unfunded superannuation liabilities on the Commonwealth’s balance sheet represent a significant risk to the long-term financial position of the Commonwealth. The unfunded liability for defined benefit schemes is currently estimated at some $150 billion rising to over $350 billion by 2050. These liabilities will have to be paid for by future generations.

Steps should be taken now to better manage them. The main unfunded defined benefits scheme that continues to be open to new members is the Military Superannuation and Benefits Scheme. Australia has an obligation to look after our serving personnel particularly their cover for death and disability.

The Commission recommends that the Military Superannuation and Benefits Scheme be closed to new members and replaced by an accumulation scheme for new Australian Defence Force personnel. The new scheme should be designed in a way that recognises the special contribution these Australians make to the defence of the nation, including by ensuring that younger, lower rank and often shorter serving members have superannuation arrangements that are equitable when compared to those of long-serving, higher-ranking members.

In considering issues around the balance sheet, it is important to recognise governments take risks onto their balance sheet when they provide guarantees and loans (including concessional loans) to people, organisations and other countries. Examples include guarantees of $13 billion of aged care accommodation bonds and $3.3 billion in liabilities of the Export Finance and Insurance Corporation.

Public information on the attendant risks accompanying these guarantees and loans is relatively poor. By failing to properly price the risk taken on by government, there is insufficient tension to ensure the government balance sheet is used sparingly and carefully. The Commission recommends that the expected costs and risks of all existing and new Commonwealth loans and guarantees should be included in the Budget, meeting the same high standards expected of the corporate sector.

Reforming the Federation

The current operation of the Federation poses a fundamental challenge to the delivery of good, responsible government in Australia.

There are numerous spending examples with significant Commonwealth and State overlap, and numerous instances where the Commonwealth provides tied funding to the States to deliver specific outcomes or policies.

A feature of the Australian Federation is the extent of the imbalance in the revenue raising capacities and spending responsibilities of the different tiers of government (the vertical fiscal imbalance).

A shown in Chart 6, this reflects the fact that the Commonwealth raises revenues in excess of its spending responsibilities, while State governments have insufficient revenue from their own sources to finance spending responsibilities.

Chart 6: Revenue and spending imbalances in the Federation

The Commission recommends that the degree of vertical fiscal imbalance within the Federation be substantially reduced with a corresponding reduction in the Commonwealth’s taxation revenue.

This would have a beneficial impact on the efficiency and effectiveness of governments. It would also increase the accountability of Commonwealth and State governments as the link between their taxing and spending decisions would be clearer to the electorate.

Any reform of financial arrangements cannot be done in isolation from the need to rationalise the duplication of expenditure responsibilities between different levels of government.

In determining ‘who should do what’ the Commission considers two key principles should apply – subsidiarity and sovereignty.

Under the principle of subsidiarity, policy and service delivery should, as far as practicable, be devolved to the level of government closest to the people receiving the services. This recognises sub-national governments are likely to have greater knowledge of the needs of citizens affected by their policies. It allows programmes to be tailored to meet community needs and recognises the significant differences across the nation.

Under the principle of sovereignty, as far as practicable, each level of government should be sovereign in its own sphere. When reviewing roles and responsibilities, government activities should be allocated to one level of government where possible. This provides greater clarity and accountability.

In addressing the issue of vertical fiscal imbalance, the Commission supports an arrangement whereby the Commonwealth would lower its personal income tax rates to allow room for the States to levy their own income tax surcharge.

The impact of lower revenue collections for the Commonwealth would be offset through an equivalent reduction in the payment of other financial assistance to the States. In other words, the States would receive a new untied source of revenue (through the personal income tax system) in place of tied grants.

The Commission has also examined issues around horizontal fiscal equalisation within the Federation and recommends moving toward a model where there is minimal redistribution between the current donor States (New South Wales, Victoria, and Western Australia) as well as Queensland, but with targeted distribution towards the current recipient States (South Australia, Tasmania, the Australian Capital Territory and the Northern Territory).

Under this approach all States would receive an equal per capita distribution of goods and services tax collected. However, to preserve the current share of the fiscally-weaker States, the Commonwealth would make ‘top up’ payments out of its own revenue base (to effectively increase the size of the pool).

As part of any agreement to move to new financial arrangements within the Federation, it would be necessary to negotiate a transfer of responsibilities for areas of spending where the Commonwealth currently makes tied grants.

Reform of the Federation including by addressing the problem of vertical fiscal imbalance provides an opportunity to significantly reduce duplication and red tape. It would also allow the Commonwealth to significantly reduce its involvement in several key areas such as education and aspects of the health system thereby improving efficiency and facilitating greater accountability.

Any changes to Commonwealth-State financial architecture along the lines outlined above would represent a substantial reform. The detailed design and ultimate implementation of any changes would be complex and take some time to implement. That is no reason for this reform not to be undertaken.

In the meantime, immediate steps are needed to simplify the large number of existing Commonwealth-State agreements.

In recent decades, the operation of the Federation has been characterised by a proliferation of small payments to the States, with increasing Commonwealth control involving excess red tape and excessive reporting requirements.

As at 1 July 2013 there were 144 agreements in place under the Intergovernmental Agreement on Federal Financial Arrangements.

All National Partnership Agreements should be reviewed, with a view to rationalising their number. This would reduce the administrative burden for both the Commonwealth and State governments.

At the same time, it would be useful to re-examine performance reporting requirements, along with broader data and transparency requirements.

If a substantial rationalisation of National Agreements and National Partnership Agreements could be achieved alongside a streamlining of reporting and data requirements, then the role of the COAG Reform Council would be substantially diminished. It could be abolished as a separate entity, with its reporting role assumed by the Productivity Commission.

Managing expenditure growth

Major reforms to the 15 largest and fastest growing areas of Commonwealth spending are essential for managing and restraining growth in overall government expenditure. There are also worthwhile opportunities to improve the effectiveness of government by more tightly targeting industry assistance, re-assessing other significant Commonwealth programmes and reforming programmes that duplicate State responsibilities. A detailed portfolio-by-portfolio review would no doubt yield further worthwhile savings.

Throughout its deliberations the Commission has been guided by the overall Principles of Good Government articulated earlier – going to the question of what governments should do and what individuals should do for themselves. It is also important to ensure that the government lives within its means and spends taxpayer funds well, including through the appropriate targeting of payments.

The Commission has made recommendations on 15 major programmes to improve their effectiveness and better manage overall expenditure growth.

The Age Pension should be maintained as an essential part of Australia’s social safety net, but changes are necessary to keep it affordable and appropriately targeted. This includes changing benchmarking arrangements and eligibility requirements. As many Australians make significant decisions in the lead up to their retirement, ample warning should be provided to future retirees of any significant changes. No existing recipient of the Age Pension will have their pension amount reduced in real terms as a consequence of the Commission’s recommendations. Under the Commission’s proposal to benchmark the Age Pension to 28 per cent of Average Weekly Earnings over a period of around 15 years, the Pension will still increase but will grow more slowly than in the recent past. From 2027-28, for new recipients, the Commission proposes changes to Age Pension eligibility including a comprehensive means test (including for some recipients part of the value of the principal residence) as well as tighter targeting arrangements. Further increases in the Age Pension eligibility age are also recommended from 2033 to establish a formal link to life expectancy.

The Commission supports the National Disability Insurance Scheme but considers it should be implemented in a way that is fiscally sustainable and able to meet the expectations of people with disabilities. The Commission believes there should be a slower roll out of the scheme. It is also essential that the cost of the scheme be strictly controlled. The governance arrangements for the NDIS are complex, with multiple layers of responsibility, and should be reformed. This can be achieved by making the National Disability Insurance Agency a prescribed statutory agency with a Chief Executive Officer reporting directly to the Commonwealth minister. The governance changes would have no impact on eligibility for the NDIS or the proposed financial contributions of the Commonwealth and the States.

Health care spending represents the Commonwealth’s single largest long-term fiscal challenge, with expenditure on all major health programmes expected to grow strongly to 2023-24 and beyond. Putting health care on a sustainable footing will require fundamental changes to all the components of the health system. Those with the capacity to pay should take greater responsibility for their own health care needs. Co-payments for all Medicare funded services are proposed along with reforms to improve the effectiveness of private health insurance arrangements and the effectiveness of Medicare. The Minister for Health should also be tasked with developing longer term options for reforming Australia’s health care system.

Strong growth in hospital funding is largely driven by the Commonwealth’s commitment to fund 45 per cent of the efficient growth in public hospital costs from 2014-15 and 50 per cent from 2017-18 onwards. The Commission considers that public hospital service provision should remain the responsibility of the States and that hospital funding should be considered in the context of addressing vertical fiscal imbalance. A closer matching of revenue-raising capacity with expenditure responsibilities would result in greater flexibility to the States to deliver their public hospital services. The Commonwealth could renegotiate the health funding commitments and, in the meantime, limit its funding contribution to public hospital services to 45 per cent of the efficient growth in this cost.

The Pharmaceutical Benefits Scheme is an integral part of the health system but a more holistic approach is needed to manage it. The Commission proposes that a new independent authority oversee management of listing drugs within a designated seven year funding envelope. Co-payment arrangements for the PBS should also be changed so that all users pay at least some contribution to the cost of medicines. To improve consumer choice, the pharmacy sector should be opened to competition.

Around 70 per cent of Australian families currently receive some form of support through Family Tax Benefits A and B. Family Tax Benefits should be better targeted to those in need and simplified with a view to boosting workforce participation. The Commission recommends Family Tax Benefit Part B be abolished with a new supplement paid to sole parent families who lose this benefit. Eligibility for Family Tax Benefit Part A should also be tightened.

The Commission recognises Paid Parental Leave has the potential to support maternal and child health. However, the benefits of Paid Parental Leave have to be balanced with the cost to the Commonwealth Budget and the principle of targeting expenditure to those most in need. The Paid Parental Leave payment should be capped at Average Weekly Earnings. The Commission considers that the company tax surcharge intended to partly fund the Scheme be retained, with savings from the lower cap redirected to an extended form of child care assistance. This would include assistance for in-home care and other types of care that are currently not subsidised. Child care assistance more generally should be simplified and broadened by replacing the current dual assistance system with a single, means‑tested payment reimbursing all parents for a proportion of their child care costs.

The Commission considers that there should be a fundamental clarification and simplification of the roles and responsibilities around school education. All policy and funding responsibility for government and non‑government schools should be transferred to the States, with the Commonwealth providing annual funding in three separate, non-transferrable pools – one each for government schools, Catholic systemic schools and independent schools. Annual per student funding from 2018 would be set at 2017 levels in each State and indexed by a weighted average of the Consumer Price Index and the relevant Wage Price Index. Of course, national standards and performance reporting to the community should be maintained.

The Commonwealth’s approach to Defence funding should be set on the basis of first determining the defence capability the country requires given the strategic circumstances it faces, and then matching this with appropriate funding. As part of the new Defence white paper process, the Government should assess the balance of strategic and fiscal priorities and how this compares with the commitment for Defence spending to reach 2 per cent of GDP within a decade. Defence budgeting should also be clarified and made more transparent, with greater scrutiny through the Government’s Expenditure Review Committee. The Commission also recommends that the Defence Materiel Organisation be reintegrated into the Department of Defence. New arrangements should be put in place to ensure greater individual accountability for the Secretary of the Department of Defence and the Chief of the Defence Force through a clearer delineation of their roles and responsibilities. The headquarters structure in Defence, including the number of senior positions, should be realigned to 1998 levels. ASC Pty Ltd and Defence Housing Australia should be privatised.

With an ageing population, further improvements could be made to the sustainability of Australia’s aged care funding by progressing reforms previously suggested by the Productivity Commission. This includes reforms to ensure the full value of the principal residence is included in the current aged care means test. The Government should examine options to improve older Australians’ access to equity in their principal residence, to help pay for part of the cost of their aged care services.

The number of recipients of Carer Payment and Carer Allowance has grown very strongly over the last decade and assistance is not always well targeted. Assistance should be better targeted to those most in need. Changes should be made to: ensure Carer Payment is paid to those whose caring responsibilities limit their capacity to work; introduce an income test for the Carer Allowance; and impose a limit of one annual Carer Supplement payment per carer.

The Commission recommends retaining Australia’s current unemployment benefit arrangements as a major pillar of the social safety net but making changes to improve incentives to work including: requiring single young people without dependants or special exemptions on the Newstart Allowance to relocate to higher employment areas after 12 months on benefits; and increasing the income test withdrawal rate for the Newstart Allowance. The Commission also considers that containing future growth in the minimum wage would improve job opportunities, especially for lower skilled Australians. It will also ensure that government programmes to get people into work are more effective. The Commission also recommends that minimum wages be set on a State basis to better reflect local labour market conditions and cost of living expenses.

The Commission recommends the Disability Support Pension be maintained as an essential part of Australia’s social safety net but changes be made to ensure it remains fair and paid to those genuinely unable to work. This includes moving to gradually apply the new disability assessment and participation criteria, introduced in January 2012, to targeted groups of Disability Support Pension recipients previously grandfathered, including those under the age of 35 and those with some work capacity.

The Commission considers that a rebalancing of the public and private contributions to higher education is warranted, reflecting the substantial private benefits that arise from higher education. The proportion of higher education costs paid by the Commonwealth should be decreased to an average of 45 per cent, with the proportion of costs paid by students rising to an average of 55 per cent. Changes should be made to the existing Higher Education Loan Programme arrangements to increase repayment rates by lowering the income threshold at which student loans are repaid and ensure interest rates reflect the Commonwealth’s full costs in making these loans including the cost of bad and doubtful debts. The Commission supports the current review of the demand-driven system and has concerns about the impact of that system on standards.

The Commission considers that Australia’s foreign aid programme needs to be more effectively managed and strategically targeted. Official development assistance should not be tied to a target such as 0.5 per cent of Gross National Income. The fragmentation of Australia’s aid programme should be addressed with a new focus on outcomes achieved rather than the quantity of resources applied.

Other programmes and spending

The Commission has been asked to ensure taxpayers are receiving value for money by presenting options to eliminate wasteful spending and improve the overall efficiency and effectiveness with which government services are delivered.

In considering these opportunities within other Commonwealth programmes and spending, the Commission’s 10 Principles of Good Government outlined above have been framed as follows:

Does the programme or activity serve a public interest and how has it performed against its target outcome?

Is there a legitimate and necessary role for government in this programme or activity?

Is the current role of the Commonwealth appropriate or is the programme a candidate for realignment within the Federation?

Can the programme or activities within it be transferred in whole or in part to the private sector or the not-for-profit sector?

If the programme or activity continues, could its efficiency be improved?

Is the programme an affordable priority within the fiscal environment?

The Commission has identified areas of Commonwealth expenditure where there is limited justification for its continued involvement or for maintaining involvement in the present form. In other cases, programmes could be better designed and targeted. For example:

The shortcomings associated with governments providing industry assistance and ‘picking winners’ are well known. The Commission considers that funds devoted to assisting uncompetitive industries could be better spent elsewhere or not spent at all. The Commission considers 22 programmes should be rationalised, phased-out or abolished.

The Commission considers that assistance to exporters through the Export Finance and Insurance Corporation (EFIC), the Australian Trade Commission (Austrade) and the Export Market Development Grants scheme should be substantially reduced. Virtually all of Australia’s exports by volume and value take place without EFIC’s assistance and the support it provides mostly goes to a small number of large businesses. Similarly, much of Austrade’s activities come at a high cost relative to the business opportunities generated. The Export Market Development Grants scheme should also be abolished as the benefits of exporting are largely captured by the business itself, with few broader benefits to the community. Forty per cent of recipients of these grants are businesses employing less than four people.

The Commonwealth provides around $9 billion per year supporting Australian research and innovation. The Commission supports this investment but considers the Government could take a more strategic, whole‑of‑government approach to the funding of research and development, including by reducing duplication in grant processes, better aligning research programmes to the Government’s policy priorities, and ceasing a range of industry-specific programmes.

The Commission considers there is scope to improve the effectiveness of Indigenous expenditure by significantly consolidating the 150 or so Commonwealth programmes, eliminating duplication with the States and discontinuing those programmes with no discernible effective outcomes. The savings from rationalisation could be redirected to a new voucher programme for accredited early childhood learning, schools, vocational training and universities for Indigenous children and youth.

The Australian Broadcasting Corporation and the Special Broadcasting ServiceCorporation are both substantially funded by the Commonwealth. The Commission considers the ABC and SBS should be independently benchmarked against both each other and the commercial broadcasters to see whether efficiencies and savings can be achieved without compromising their capacity to deliver services, including to remote and regional Australia. Future funding decisions for these organisations should be informed by the outcome of this benchmarking exercise.

Housingaffordability and homelessness prevention are important priorities for Australia, however they are the responsibility of the States. As such, the Commonwealth should limit its involvement to providing rent assistance for income support recipients. The Commission proposes that arrangements for rent assistance be extended to include payments to public housing tenants (on the basis that tenants commence paying market rates of rent). Increased funding for rent assistance would be paid for by redirecting funds currently provided to the States under existing housing agreements.

Similarly, vocational education and training has traditionally been a State responsibility. At the moment, the Commonwealth provides separate funding to encourage businesses to take on apprentices and for development including through the National Workforce Development Fund. The Commission considers the Commonwealth should pass full responsibility for vocational education and training to the States with some requirements for national reporting and quality assurance. Recent reforms to achieve demand driven training should continue to be pursued by the States, along with improvements in mutual recognition of occupational licensing between States.

Commonwealth involvement in natural disasters is identified as another area in which the States have primary responsibility. The Natural Disaster Relief and Recovery Arrangements should be replaced with a grant to affected States in the case of each major natural disaster with the Commonwealth contribution based on a designated proportion of the estimated reconstruction costs.

The Commission recommends significant improvements to Commonwealth grants programmes by: establishing a central register within the Department of Finance with complete transparency on all grants awarded; establishing and publishing clear outcomes against which each grant is regularly assessed; reducing red tape by applying contemporary risk-based approaches to grant management; and decreasing the number of existing grant programmes. The Commission further proposes that, for each portfolio, all grant programmes with a value of less than $5 million across the forward estimates should be consolidated with funding reduced by 15 per cent by 2015-16.

Agencies and bodies

There are too many government bodies in Australia. This leads to duplication and overlap, unnecessary complexity, a lack of accountability, the potential for uncoordinated advice and avoidable costs. There is no central repository of information on these bodies.

In considering the potential for rationalisation of bodies, the Commission has initially focused on the 194 principal Commonwealth bodies that operate under the Financial Management and Accountability Act 1997 and the Commonwealth Authorities and Companies Act 1997.

Some 99 of these bodies warrant action. The Commission recognises that further investigation may be required regarding these suggested rationalisations.

Among the opportunities for major consolidations of Commonwealth agencies, the Commission proposes:

establishing a single, integrated border agency, to be known as Border Control Australia, through the merger of the border control functions of the Department of Immigration and Border Protection and the Australian Customs and Border Protection Service;

consolidating crime intelligence capability by merging CrimTrac with the Australian Crime Commission; and

consolidating Commonwealth health-related bodies by establishing a National Health and Medical Research Institute to better embed health and medical research in the health system. The Commission separately proposes that seven agencies within the Health Portfolio be consolidated into a new Health Productivity and Performance Commission. This new body should help to drive improved performance across Australia’s health care system.

As well as the 194 principal bodies, the Commonwealth supports around 700 other bodies including boards, committees and councils.

The Commission has commenced a preliminary examination of these bodies and recommends each department reassess all committees, councils and boards within their portfolio with a view to reducing their number and associated overhead costs. In addition, the Commission recommends guidelines be introduced to govern the creation of any new government bodies and a central public register be established.

Improving government through markets and technology

The Commission has been asked to report on efficiencies and savings to improve the effectiveness of government through greater use of markets and technology.

The Commission recommends that a number of entities be privatised including in the near term: Australian Hearing Services; Snowy Hydro Limited; ASC Pty Ltd; and Defence Housing Australia. In the medium term the Australian Postal Corporation; Moorebank Intermodal Company Limited; Australian Rail Track Corporation Limited; Royal Australian Mint; and COMCAR should be privatised.

Within government, there is also scope to make better use of market mechanisms to drive efficiency and effectiveness, including outsourcing, competitive tendering and procurement. The Commission has made recommendations on improved guidance and standardisation regarding competitive tendering and procurement (to ensure value for money and best practice contracting models); and a whole of government user‑charging framework.

The Commission has examined specifically outsourcing the Government Payments System. The Commission recognises that maintaining a welfare system is a core function of government. How payments are made and how people are assessed for eligibility is central to an efficient welfare system. Any decision to outsource the payments system must recognise this as well as other significant risks involved. These risks are amplified by the need to replace the existing information technology system that underpins the Government Payments System.

The Commission proposes the appointment of a highly credentialed business technology expert to oversee the development of the new payments information technology system in collaboration with the Department of Human Services. A scoping study on options for outsourcing all or parts of the Government Payments System should also be developed. Assessment of eligibility of recipients should remain within government.

The Commission has identified several areas where the Government could better harness technology to improve services and inform policy, including through greater use of data analytics and more assertive requirements to use cloud computing for non-core IT services. While progress has been made towards e-Government in Australia in recent years, the Commission considers that there is an opportunity to significantly accelerate the transition to digital service provision. The Commission accordingly proposes the Government commit to an ambitious ‘digital by default’ strategy that sets clear targets and removes barriers to digital services, and appoint a senior chief digital officer to drive change in the public service.

The Commission has also identified opportunities to improve the efficiency of corporate functions in the Australian Public Service, through standardising corporate business processes, improving procurement of business systems, and the staged adoption of shared corporate services for appropriate groups of agencies.

Reform and restructure of the Australian Public Service

Throughout its deliberations the Commission has been provided with a range of views on the structure, performance and effectiveness of the Australian Public Service.

At the whole-of-government level, the machinery of government changes implemented in September 2013 have significantly simplified and streamlined arrangements.

However, a more efficient and effective public sector also requires appropriate structures within portfolios and within individual organisations. The quality of leadership and management within the public service is likewise fundamental to improving operational performance.

In its Phase Two Report, the Commission intends to examine in more detail issues associated with potential reform of the Australian Public Service, including the role of the Australian Public Service Commission.

The Commission will consider whether there are improvements to be made through:

clearer accountabilities and better alignment of roles and responsibilities;

greater efficiencies in corporate and support functions across government.

Financial Implications

The Commission has made 64 recommendations across a range of activities and programmes, consistent with the objective of achieving a surplus of 1 per cent of GDP by 2023-24.

Most of our suggested actions go to the structural design of the biggest and fastest growing programmes. A detailed portfolio‑by‑portfolio review should yield further significant additional savings but insufficient to fix the underlying fiscal problem.

The Commission has prepared estimates of indicative savings from its recommendations. However, without decisions on detailed programme design and timing of implementation — which are matters for the Government — it is not possible to be definitive.

Detailed costings undertaken by Government as part of the Budget process would give greater clarity around the financial implications of the recommendations.

The Commission expects that these more detailed costings would yield modest savings in the early years rising to some $20 to $30 billion per year by 2017-18. By 2023-24, the savings could grow to some $60 to $70 billion per year.

These estimated savings do not factor in the additional savings from lower public debt interest costs arising from lower levels of Commonwealth debt which could be in the order of $15 to $20 billion per annum by 2023-24.

Chart 7 illustrates the potential magnitude of the savings.

Chart 7: Potential savings from the Commission’s recommendations

It should be noted that the Commission has not included in its projections the Government’s commitment to increase Defence expenditure to 2 per cent of GDP.

Conclusions

The Commission supports the Government in its commitment to get the nation’s fiscal house in order.

This report has laid out a broad reform agenda that recognises the legitimate role of government and sets the Commonwealth Budget on a more sustainable path.

We have to restrain spending, rebuild our financial capacity and restore the buffer needed to shock-proof the economy from a future crisis.

The Commission has made 64 recommendations across a range of activities and programmes. These savings, or other savings of a similar magnitude, are needed to deliver a surplus of 1 per cent of GDP by 2023-24.

The aspiration is for more responsible government – to spend taxpayers’ money wisely and focus more on what governments should do, rather than on those things that citizens can best do for themselves.

The Commission believes that ‘business as usual’ is not a viable option for Australia. Unless we take action now, there is a very real prospect of an unprecedented run of budget deficits and a build up in net debt. This would place a significant burden on future generations to bring the Budget back under control.

Achieving the target surplus will require a significant reduction in spending, while holding to a discipline that taxes rise no higher than 24 per cent of GDP. The Commission’s proposals can be implemented incrementally and in a way that does not harm the economy. In fact, taken together they should strengthen the economy.

Australia needs to embark on a path of reform and renewal. Restoring the nation’s finances can be achieved through a concerted effort to restrain spending assisted by fiscal rules that set some reasonable boundaries around government.

Good government breeds confidence.

Governments that successfully manage their own affairs set an example to the rest of society about their ability to cope with economic and social challenges.